Countrywide On Clearance

Countrywide Financial may have found a white knight in Bank of America, but the mortgage lender was forced to put itself on the auction block for a steep discount.

On Friday, Bank of America confirmed that it will buy Countrywide Financial for $4.1 billion, delivering a much-needed lifeline to the embattled mortgage lender. But the deal, which values Countrywide's shares at $7.07 a share, well below Thursday's closing price of $7.76, simultaneously exposes the dire state of the nation's largest mortgage lender and the industry as a whole.

In early afternoon trading, shares of Countrywide plunged 16.3%, or $1.26, to $6.49, while Bank of America edged down 1.2%, or 47 cents, to $38.83. This deal comes together because no one wanted to see Countrywide fail; it is a win-win for everyone involved, but doesn't indicate that the mortgage problems are behind us, Stifel Nicolaus analyst Christopher Brendler told Forbes.com.

Under the deal, Countrywide shareholders will get 0.1822 of a Bank of America share for each share that they own.

The fact that Countrywide was willing to take a deal that valued it shares 8.3% below trading levels reveals just how desperate the firm was. It was certainly good news for Countrywide, Brendler said. Countrywide was going to have funding issues, liquidity had dried up for the sector, bankruptcy was a real risk.

This is not the first time Bank of America has stepped in to stabilize Countrywide. Back in August, Bank of America pumped $2 billion into Countrywide, buying up 111 million shares at $18 a share. According to Brendler, Bank of America was likely interested in buying Countrywide then, but Countrywide was hoping to go it alone. Since August, the credit and housing markets have worsened considerably, forcing many firms to take big write-downs or close their mortgage business alltogether. The rapid deterioration has pummeled Countrywide Financial, and, with Chapter 11 rumored to be at its heels, the firm likely had no choice but to accept a lowball deal.

This week, Countrywide reminded the markets that foreclosures were on the rise and said it funded just $23.5 billion in loans in December (roughly half the volume of a year ago).

Although Bank of America's stock may react negatively to the bailout news, the takeover of one of the most high-profile mortgage franchises at a bargain-basement price will be accretive in the long run. The acquisition, which will likely pass regulatory approval and close by the third quarter, will automatically turn Bank of America into the country's largest mortgage lender. As a major Wall Street player, with a huge balance sheet, Bank of America can easily absorb Countrywide's troubled portfolio. While the mortgage mess is far from over, Bank of America predicts that the takeover will be neutral to earnings in 2008 and positive by 2009.

Countrywide presents a rare opportunity for Bank of America to add what we believe is the best domestic mortgage platform at an attractive price and to affirm our position as the nation's premier lender to consumers, Bank of America Chief Executive Officer Ken Lewis said on Friday.

Of course, Countrywide is no sure bet. The company still has a dicey portfolio, with $80 billion in high-risk mortgage loans. Several months ago, many of these loans were not considered high risk, but the deterioration of the markets now makes them so, Stifel Nicolaus's Brendler said. Bank of America also acknowledged the possible risk associated with Countrywide in Friday's statement: We are aware of the issues within the housing and mortgage industries....The transaction reflects those challenges.

The Countrywide deal may also be a sign that the mortgage market will continue to worsen before it improves. This is more of a negative indicator; you have a company that has tried very hard to stabilize but has clearly failed to do so, and is selling for a very depressed price, Brendler remarked.

Others may follow. The next takeover target could be Washington Mutual, which ticked up 6.1%, or 87 cents, to $15.03 in premarket trading. However, Washington Mutual is a much larger pill to swallow, with $250 billion in mortgage loans on its books and a $12.3 billion market capitalization. Despite an attractive retail deposit business, there would be a limited pool of suitors. The top candidate would likely be JPMorgan Chase, Brendler observed.